Russia, Eastern Europe and China are in the process of a transition from the highly centralised hierarchical organisation of central planning to a liberal market environment. The decision-makers' response to the bureaucratic failure of central planning has been greater reliance on the market mechanism. This paper, using case studies from the car industry as an illustration, discusses the organisational aspects of this transition, and in particular the position that former state-owned enterprises in Russia, China and Hungary are occupying in the hierarchy-market continuum.
As Williamson (1985) argues, there are a number of organisation structures that fall between the extremes of pure hierarchy and pure market. The position of companies in a particular sector or economic system within the hierarchy-market continuum is contingent on the extent of market or bureaucratic/administrative failure. Therefore, between these opposite poles of industrial organisation lies a spectrum of forms in which modern economic activities are organised, e.g. 'networks' (Thorelli, 1996), 'hybrids' (Williamson, 1991) and 'clans' (Ouchi, 1980).
With the beginning of the process of economic reform and industrial restructuring in China, Eastern Europe and Russia, the search began, through a series of experiments and economic set-backs, for a form of governance that could integrate bureaucratic and market transactions. Although in the first stages of economic reforms these countries employed similar strategies of economic liberalisation and industrial restructuring, at present their industries are taking very different directions of organisational change. In Russia the shape of restructuring at the micro-economic level has been determined by the process of mass-privatisation with the consequent development of internal and external mechanisms of corporate governance and control (see, for example, Filatotchev et al, 1996; Kochevrin et al 1994). In China, the process of economic liberalisation and 'openness' with respect to direct foreign investment was followed by the rapid development of hybrid bureaucratic-market organisational forms described in the literature as 'fiefdoms' (Boisot and Child, 1988), 'boundary-blurring' (Peng, 1995) and 'networks' (Child and Lu, 1990). In Hungary, gradually increasing liberalisation and economic decentralisation from 1968 onwards and more recently dependence on direct foreign investment has generated a 'segmented' economy comprising hybrid-market organisational forms termed 'recombinets' - networks of state and privately owned assets (Stark 1995) and hierarchical modes of entry by state-supported foreign investors (Sadler and Swain 1994).
This paper discusses the dramatic organisational changes developing inside the industrial sectors in Russia, China and Hungary. Detailed case study evidence on selected car-making companies which dominate the total production of cars in these countries has been obtained by the authors during face-to-face interviews in the course of a number of field trips.
Although the authors agree in principle with the existence of 'hybrid' forms of industrial organisation, in the cases of Russia, Hungary and China, they try to show that the major processes of organisational restructuring differ dramatically in these countries. The authors consider the particular positions the typical company occupies within the market-hierarchy continuum to be temporary equilibria. This is because given the dynamic nature of environmental uncertainties in these countries one can expect further evolutionary development of organisational forms at the company level.
2. Organisational Changes: Different Routes
The changing economic environment in transitional economies was accompanied by a dynamic process of organisational change. The basic thrust of the reforms in Eastern Europe and elsewhere in the world was toward a decentralisation of decision-making in which firms acquired greater freedom to pursue their own economic objectives. In China and Hungary and to a lesser extent in Russia the economic reforms involved a controlled delegation of supervisory responsibilities within the state bureaucracy to both provincial and city levels. As a result of these changes industrial organisations in these countries started to move from the hierarchical end of Williamson's market-hierarchy continuum towards the market end.
Consequently new organisational forms are developing in unique national, cultural, legal and institutional environments, a particular state of temporary equilibrium depends not only on the extent of market or bureaucratic failures (and the level of related transaction costs), but depends also on the way path-dependent institutional legacies shape the strategic dilemmas from which new institutional structures emerge (Hausner et al. 1995).
In environments where the legal framework is inadequate and hierarchical structures are weak, trust-based informal networks are an effective organisational form capable of regulating economic activities. Instead of relying on legal mechanisms of contract re-enforcement or power relations, networks place heavy reliance on reciprocity, collaboration, and interdependence among members (Peng, 1994). Peng emphasised that the network organisation is a way to internalise those transactions which are subject to volatile influences in developing economic and legal environments.
Boisot and Child (1988) emphasised the role of production and exchanges of information in the process of transactions. The structures through which transactions are governed differ in the ways they express and distribute information (the authors call it 'codification'). In both China and Russia the transition from central planning to market left state-owned enterprises in a situation characterised by a very low level of codification in which information diffusion is limited to face-to-face relationships. This inevitably gives rise to organisational structures which the authors call 'fiefdoms', i.e., hierarchically structured through face-to-face and personalised power relationships in organisations.
An important role in the development of such organisations is played by the characteristics of strategic leaders (former 'red directors'). For instance, Hoskisson, Hill and Kim (1993) suggest that top managers with long tenure very often share the same values and norms and agree with the way the company is managed. Long tenure may encourage the formation of clan (cooperative) organisations. Finally, the geography of bureaucratic planning, combining localised specialisation (Grabher and Stark 1996) and 'hub-and-spokes' networks linking the centre with outlying areas (van Zon 1992), reinforced the development of locked-in localised fiefdoms (Burawoy and Krotov 1992) which were 'over-embedded' in localities (Smith and Swain 1997).
3. Problems of Privatisation and Corporate Governance in Russia
Rapid disintegration of the central planning mechanism in Russia at the end of 1980s was followed by the formation of such organisations as 'concerns', 'consortia', 'industrial associations', and other forms of economic organisation, whose major role was to replace failed hierarchies of central planning with some meaningful bureaucratic mechanisms of corporate governance, as well as to try to reduce dramatically increasing transaction costs through internalisation. This process can be characterised as 'top-to-bottom' development of organisational networks, since the driving force behind this process was the former economic bureaucracy of the central planning system. The process of economic and political democratisation meant that members of the disintegrating hierarchies of central planning, which were quickly losing political power, tried to compensate by increasing economic power. Instead of an indirect political rent they were trying to obtain a more direct, economic rent taking top positions in the management teams of newly created associations.
There was a limit to such growth due to the existence of organisational (bureaucratic) costs, which were the direct result of the problem of control loss due to information processing constraints and the bounded rationality of top decision-makers (Jones and Hill, 1988). Rather loose mechanisms of corporate governance within associations have given rise to agency problems, when members of broadly shaped associations behave opportunistically or choose free riding. The collapse of the former uniform Soviet market and centralised banking system has increased transactions costs dramatically, far beyond the limits of the associations' ability to accommodate and reduce the costs.
The beginning of mass-privatisation in Russia has accentuated the agency problem within these new organisations. The privatisation programme transferred assets out of the public sector by virtually giving them away in exchange for vouchers issued to all adult citizens. As a result, insiders typically obtained controlling ownership stakes and the incentives that go with equity ownership, but external corporate governance may be weak because of the absence of oversight from outside investors and financiers (Filatotchev et al. 1996). The added problem is that employees seeking to hold on to their jobs may resist managerial changes or collude with those Red Directors who are unwilling to change. Only if their jobs are at serious risk may they be willing to support outsiders in replacing management. These difficulties may be bolstered in an environment where, although the necessary legislation has been enacted, enforcement of the bankruptcy threat is weak and the take-over threat in an undeveloped capital market with general insider control of enterprises is remote. Additionally, the pressure from competition in product markets has yet to develop.
The case of Gor'kovskii Avtomobil'nyi Zavod ('Gorky Automobile Plant') or GAZ, the largest Russian car and truck manufacturer, illustrates problems of post-privatisation restructuring in the Russian car-manufacturing industry in particular and in the industrial sector in general.
Case Example: GAZ. The 110,000-employee GAZ produces cars, trucks and standard engines and chassis sets on which other plants elsewhere in Russia fit superstructures such as minibuses and tanks. The company which also has a vast commitment to social facilities for a community of 300,000 people was privatised in mid-1994 by Presidential decree as it was too politically sensitive to utilise the variants of the main privatisation program. For decades prior to the break-up of the USSR, GAZ had been struggling and failing to produce more modern products which would stand comparison even with local competitors. Things went from bad to worse after the collapse of the USSR as traditional markets for trucks virtually disappeared as customers could not pay for GAZ products. However, sales of the traditional Volga car have increased at a time when other Russian car producers are reducing output, and market share has increased to 15 percent. Today GAZ can be characterised as possessing a production line for a full range of relatively simple cars and trucks which makes maximum use of standardised components; constant development of new models on the basis of old prototypes; 'auxiliary production' (seven-day week three-shift day working) which provides for rapid readjustment of the main production lines for the output of relatively successful new models (such as the Gazelle pick-ups, which it had been unable to do under central planning); and a high level of centralised decision-making. Nevertheless, there remain problems of out-dated technology and the build quality of the vehicles. The dealer network is seen as a liability as it is unable to secure adequate sales revenue. Employees now own 67 percent of GAZ equity, management 13 per cent and private individuals 20 per cent. There has been no compulsory downsizing, wages remain high by local standards and social expenditures have been maintained in real terms. These factors together with the pressure coming from both trade unions and employees have reduced the management's ability to reorganise the production process. GAZ faces significant financial problems due to its indebtedness to the state, its massive social commitments, the local government authority's unwillingness to help with infrastructure and taxes, and increasing input and decreasing output prices.
For the future it is expected that while many enterprises will retain insider control, a significant proportion will see insider control degenerate as outsiders gain substantial equity stakes. Eventually newly-privatised companies will be confronted with the tremendous task of 'deep' technological restructuring and modernisation. Lacking the necessary expertise and finance they will have to turn to outside investors. Ultimately, an effective system of corporate governance could be secured by transferring control rights from managers and employees to outside investors. In other words, with free tradability of shares, the Russian voucher privatisation would be followed by the gradual erosion of insider ownership and creation of an Anglo-American corporate governance mechanism.
However, in some enterprises there is clear resistance to outside intrusion, even when capital infusions would clearly benefit both managers and employees. Phenomena such as insiders' behaviour geared to employment preservation, difficulties with protecting outside minority shareholders' interests, as well as the passive role of risk-averse outside shareholders and financiers seem to represent more than a temporary deviation away from "textbook" models of corporate governance. Moreover, there is clear evidence that so far the majority of newly privatised Russian companies have failed to attract both domestic and international outside investors who could provided financial resources so desperately needed for companies' restructuring and modernisation (EBRD, 1995, Chapter 8; Willer and Nash, 1996).
Case Example: GAZ. A number of joint ventures have been established with primarily US (Rand-Ingersoll and Haden), Czech and Austrian partners. However, managers, mistrusting the motives of foreign companies seeking to acquire shares in GAZ directly, have dissuaded many such investors. The sale of shares to outsiders is prevented by the GAZ President's own private company which buys the shares and resells them to other employees. The company prefers to rely on internally generated income and bank loans as a source of finance. For example, it has received a loan from the European Bank for Reconstruction and Development on favourable terms and has offered bonds to private individuals. Most importantly it has developed a portfolio of financial assets comprising commercial bills, accepted at a discount in payment for trucks, and controlling stakes in a number of subsidiaries. It transfers to the Ministry of Finance and receives tax deductions for their bills' face value. It is attempting to sell stock acquired for cash or swap for more attractive investments. Many formally independent plants sell all of their output to GAZ and are willing to exchange a controlling share in their capital for the security of being part of GAZ, the only dynamic car manufacturer in Russia today.
For foreign firms and investment funds seeking to invest in Russian firms insider control creates serious problems. Given the widespread resistance to outsiders, investors need to develop a longer term strategy of developing trust relationships with firms. Probably the best approach is to pursue strategic alliances which facilitate entry through collaboration with a Russian partner. This was clearly indicated in the multiple foreign partners associated with GAZ. Although GAZ management was distrustful of such partnerships, there was a clear need for partnering because of the outdated technology and production processes at GAZ. Thus, considering a wide range of cooperative approaches such as licensing agreements, contracts, joint manufacturing and other strategic alliances is probably the best mode of entry.
Russian organisations are gradually moving towards the market end of the 'hierarchies-market' continuum. Development of capital markets, legal reform and institutional changes also stimulated the movement along the institutional/information continuum, positioning Russian companies closer to the market/'developed codification' end of the organisational continuum.
4. 'Boundary Blurring' and Industrial Networks in China
The process of organisational restructuring in China is quite different to that in Russia. The government in China still imposes the 'three no' policy governing the process of organisational change: no change in affiliation relations with government agencies; no change in the nature of ownership; and no change in fiscal and tax remittance channels (Peng, 1995, pp. 17-18). As a result, the transition of Chinese enterprises within the 'hierarchies - market' continuum led to networking or 'boundary blurring' processes. These inter-organisational networks serve as a strategic alliance of the firms involved while avoiding the politically sensitive task of ownership transfer. They also reduce the environmental uncertainties through the development of inter-company relationships.
Unlike in Russia, this process of restructuring can be called a 'bottom-top' approach. In the absence of any substantial democratisation of political and economic life the members of the planning bureaucracy in China have not lost their political power, and political rents based on this power have not diminished. On the contrary, the striving for even higher rent explains why the economic bureaucracy, especially at the regional and city levels, is doing its best to promote the aforementioned process of organisational change on a large scale. Hoping to capitalise on economies of scale, the local authorities encourage the expansion of newly created groups around large industrial companies, so that they include members under the control of different agencies.
There is vast case study evidence that the particular composition of these groups is a result of strategic decisions of managers of leading or 'core' companies rather than the planning bureaucracy (Byrd, 1992). As a rule, representatives of local Party office and regional authorities sit on the Boards of the groups. The composition of newly created networks or 'groups' varies in China. The relations between the group headquarters and its associated members include a multitude of governance and control mechanisms. A typical group would include a number of closely associated core companies, usually from the same town or region. There are so-called 'closely associated factories' which have only limited freedom of action. Their managers and party secretaries are normally appointed by the headquarters. The group may include a number of joint venture type companies, so-called enterprises 'under joint management'. The core companies in the group, local governments and (in some cases) workers collectives have investments in these joint ventures. Their relationships with headquarters are somewhat more distant in comparison with the 'closely associated factories'. Finally, a typical group would include a large number of 'loosely associated' members, which preserve their original ownership, administrative subordination and fiscal arrangements. This form of association mainly involves co-operation in production activities according to contracts between the associated enterprises and the group headquarters.
Case Example: Beijing Automotive Corporation. The Corporation has been established by and is accountable to the Ministry of Engineering of China and the Beijing City Council (the Deputy Mayor responsible for industries is also the Chairman of the Corporation). Other members of the Board are the directors of member-enterprises. The Corporation includes 19 state-owned companies, 9 collectively owned enterprises, 7 Joint Ventures (JVs) and 2 limited companies (one of them is a Hong Kong-based investment fund). Apart from that, it has close trading relations with 139 enterprises in Beijing and the surrounding region. The State Property Management Bureau has transferred the right to manage and operate the assets of all these companies to the Corporation. The total output of the Corporation's members amounts to 33% of the Chinese market for cars, light trucks and minibuses. The Corporation has taken over all the export/import and R&D activities of its members. It has its own training and information centre and provides its members with contacts with potential foreign partners. It has strong links with the state-controlled International Trade and Investment Company of China, which is used as an intermediator for access to the overseas capital markets.
Even individual large industrial companies in China include not only factories involved in the production and assembling of finished products, but also numerous producers of inputs and components. Such a strategy for growth represents efforts to reduce environmental uncertainties and other transaction costs through the development of inter-organisational relationships based on economic power (see, for example, Pfeffer and Salancik, 1978). For associated companies, a network membership provides a shield to protect them from environmental uncertainties. Very often the 'core' company is given independent status in China's state plan, and a profit-increase responsibility system granted to the 'core' company will be extended to other members of the network.
Kay (1993) argues that conglomerates may create a miniature capital market that mitigates transaction costs in the external capital market. This could happen through 1) the internalisation of capital market transactions; and 2) the creation of profit centres within the organisation. Obviously, this argument can be used as another explanation for the fact that large state-owned enterprises in China decided (with the authorities' approval) to establish a loose conglomerate-type organisational structure. Cuts in centralised funding and the emphasis on profit-retention as a source of finance in the external environment of underdeveloped capital markets forced companies to internalise capital markets to meet investment and modernisation targets. To create an internal pool of investment resources, newly established organisations with a large number of associated members have had to separate costs and profit centres. Boisot and Child (1988) mentioned that in a number of cases the profit target set by the supervising authority for the group was further broken down and allocated to individual workshops.
Case Example: Beijing United Automobile and Motorcycle Manufacturer (BUAMM). Originally the company was a Japanese-owned motorcycle repairs plant, and after the liberation of Beijing by the People's Liberation Army (PLA) it fell under the authority of the Ministry of Automobile Industry. The large-scale development of the company was promoted during the period of industrialisation. In 1956 all present plants and workshops were built for the production of cars with the help of Russian engineers from GAZ. The very first Chinese car was made in 1958. At the end of the 1950s the Chinese government decided to launch the local production of Jeeps based on the Russian model Gaz 69, and in 1963 the company started its first independent production of 2-door Jeeps (mainly for the PLA). By 1968 the company developed full capacity for car production which has remained approximately the same until now. Current combined market share of the company is approximately 10 per cent. The company consists of 10 factories located in different districts of Beijing. It produces its own instruments and tools. Its foundry (built in 1956) produces alloys not only for internal purposes, but also for companies elsewhere in China. The company's organisational structure also includes five factories under so-called 'joint management' (JME). Formally, they have independent budgets and their output is not included in the parent company's results, but costs and profits are. The company has invested in approximately 75 percent of the total assets of these former township enterprises, and formally they are a form of JV between the company and the township authorities. The decision to establish these JMEs was supported by the Beijing local authorities, who wanted to use the large pool of cheap labour in the Beijing region. It is more difficult to acquire businesses in other regions of China (outside Beijing), because this requires the permission of their local authorities. The company has a substantial social burden, which includes hospital, kindergarten, subsidised canteen, housing. Managers cannot dismiss workers without the permission of the Beijing authorities. The wage bill is controlled by the government, and the authorities also have fixed shares which the company has to pay into different social funds. The company's management consists of a General Director and deputies. The General Director is subordinate to the Beijing Automobile Corporation, which is responsible for strategic decision-making in the company. Instead of output targets (as in the previous system of central planning) the management receives annual profit targets.
Bearing in mind the scale of restructuring and modernisation problems with which Chinese companies are confronted the pool of internally generated capital is insufficient to meet the target of technological modernisation and investment set by the supervisory bodies. Moreover, there is a danger that these limited resources will be wasted on cross-subsidisation in these vaguely shaped and loosely controlled industrial associations.
The alternative is to create and isolate a profit centre with the help of a foreign partner. This partner will bring capital in embodied form (solving the technological problem) and in cash (working capital), which will compensate for inefficiencies of the internal capital market. Being a 'ring-fenced' organisation well-insulated from the destructive influence of transforming hierarchies, the joint venture will turn into an 'external profit centre' for the parent company.
These arguments partially explain why JVs rather than hierarchical modes of entry (acquisitions, green field investment, etc.) are playing a predominant role in Chinese restructuring. First, they are bringing new technology and investment resources necessary for establishing the large-scale production of world-class goods, therefore broadening the scope of potential economic rent. At the same time, the supervisory authorities are staying firmly in charge, and their political power is not diminishing. The process of setting up JVs is less transparent than, for example, an acquisition, so there is another possibility for members of the supervising bureaucracy to obtain an indirect rent. Foreigners, dealing with an established ruling elite with a strong taste for large-scale industrial production at the principals' end, and managers keen to use all hidden assets and get rid of social liabilities at the executive end, have a unique opportunity to capitalise on extremely low production costs and to exploit all the benefits of large-scale production within the 'ring-fenced' organisation.
Case Example: Beijing Jeep Company (BJC). In 1984 BUAMM set up a JV with the American Motor Company, which has subsequently been taken over by Chrysler. The Americans wanted to move into the Chinese market, and the Chinese wanted a JV with a company with long experience in making Jeeps. The Chinese share in the capital of the newly established BJC amounted to 68.65 per cent (which included building, equipment, production site) and the American share was 31.35 percent (equipment, assembly line, technical drawings, know-how and US$ 1 million cash). The main product of the JV is the Jeep Cherokee. All components are currently imported from the USA. BJC's market share is 6.74 per cent of the total Chinese car market. When BJC was founded, 78 percent of all fixed assets of BUAMM was transferred to the JV, but all social liabilities remained with the parent company. The majority of the top managers of BUAMM moved to the JV, as well as most of the R&D personnel. Of 10,000 employees in the parent company some 4,000, mainly young, elite workers went over to the JV leaving the parent company with 3,000 employees near retirement age. Nevertheless, the JV is not doing well: Jeeps are traditionally considered in China as very basic cars suitable only for the rural population. (The Beijing authorities do not allow jeeps to drive in the fast lane within the city boundaries!). Due to labour-saving technologies and the fixed price of imported components for jeeps the JV has a limit below which it simply can not reduce costs. With a rather high retail price the rich Chinese prefer to buy saloons or estates from Japan rather than Jeeps. Since almost all components are imported it is uneconomic to export the vehicles to the USA due to the high transportation costs. To reduce the prices of the model, the JV switched from the production of 4x4 vehicles to simpler front-wheel drive cars. The American partner has refused to introduce any other cost-reducing modifications because of quality considerations.
Chinese enterprise managers are caught between two millstones of competing claims of a rent-maximising state bureaucracy and a welfare-maximising workforce. As in Russia, workforce welfare in China is not confined to the wage bill and bonuses, but is a complex set of objectives, including the education of children, public health, employment, retirement pensions, training schemes, etc. But even when managerial decisions are free from employees' influence, they remain under more or less permanent threat from the local supervisory bureaucracy. This aggravates a serious agency problem at the top level of the network in terms of both adverse selection and moral hazard. Since managers often have to perform in a situation when the supervisory body uses the ratchet principle of setting profit targets according to imperfect information about production capacities, the subordinate is very likely to shirk or behave opportunistically, especially in a situation of loose corporate governance mechanisms.
The second type of agency problem can be easily identified within the networks, or groups. Being an intermediate form of governance, i.e., neither market nor hierarchy, the new industrial organisations have an important embedded deficiency: a multi-tier agency problem, which is a result of the opportunistic behaviour of managers of different associated factories and workshops. For example, opportunistic behaviour, such as undercutting other members' market share by increasing the firm's output, has been reported in Peng (1995). On the other hand, some ventures in the group may have trouble surviving without costly support from the 'core'. Intra-group financial transfers as a payment for other members' loyalty might turn into a serious drain of strategically vital resources. Some members, especially private companies and JVs which are close to the consumer end of the production process, may desert the group in times of trouble.
Case Example: BUAMM and BJC. After the transfer of a substantial share of BUAMM's assets and workforce to the BJC the Beijing government made a decision to re-build the capacity lost as a result of the transfer and to increase the volume of BUAMM's output (which fell to 4,000 cars in 1985) to its pre-JV level. BUAMM received massive centralised investment, followed by subsidised loans from the state. All profits were also used to expand production. As a result, in 1992 total output reached the peak level of 34,394 cars, but in 1993 and 1994 it fell to 25,264 and 20,929 cars respectively. Now BUAMM has found itself in fierce competition with its JV. Despite an initial agreement with the JV to sell part of Cherokee's output through the parent company's network, the JV wants to sell its products itself. As a result, BUAMM's gross profits as a proportion of sales fell from 3.9% in 1992 to 0.8% in 1995. Recently the Beijing authorities decided to introduce a new Land Code, which gives different companies the right to lease their plots of land and obliges them to pay land tax. The parent company and JV cannot decide who has the leasehold on the JV's land (it was not specified in the 1984 agreement), and who has to pay land tax. The land might be a massive hidden asset in the future, and both parties in the JV claim rights to it.
The large Chinese state-owned companies are obviously in the middle of the 'hierarchies-markets' continuum, and they will not be able to stay there long. The developing 'alternative economy' is imposing the pressure of competition on them in a situation when their governance mechanisms are suffering from severe agency problems. Decision-makers in China will not be able to maintain this status quo for long, and they only have a few alternatives.
Company supervisors may give way to market forms of governance, but they will quickly lose the ability to collect an economic rent, exactly as has happened in Russia. An alternative is that bureaucracies give way to networks when bounded rationality is presented, and information is skewed in favour of a very few opportunistic players (Boisot and Child, 1988). In this situation the managers of newly established groups will continue to exploit the emerging opportunities with a large-scale inflow of foreign capital, moving the best parts of their assets and their most able and young workers to JVs and leaving the empty shell of a state-owned company overburdened with social liabilities behind. In this way they may continue to what could be called a process of 'recycling' state-owned enterprises.
5. Industrial Restructuring and Organisational Change in Hungary
Disintegration of central planning occurred in Hungary over a period of two decades. From 1968 onwards the 'New Economic Mechanism' (NEM) liberalised the economy and increasingly decentralised economic decision-making from central planners to state-owned enterprises which operated under quasi-hard budget constraints. Managed by 'enterprise councils', enterprises utilised informal networks to bargain with the appropriate branch ministries to secure favourable financial conditions. The dismantling of hierarchical forms of governance with the only limited emergence of horizontal governance forms generated significant agency problems as individual enterprises were able to evade financial discipline (Bartlett 1996). Once the legal environment began to be reformed in 1988, the legacy of economic decentralisation prompted a phase of so-called 'spontaneous privatisation' as managers were able to translate their roles to those of owners (Stark 1992). Despite attempts to recentralise economic decision making, this time not to government ministries but to privatisation agencies, enterprises were reformed through a process of 'decentralised reorganisation'. This resulted in the formation of increasingly 'hollowed-out' enterprises comprising core (ultimately) state-owned 'holding companies' responsible for asset liabilities (principally social and fiscal) owning a considerable number of peripheral subsidiary 'corporate satellites' with their own board of directors and operating according to hard budget constraints. In this way a web of networks emerged which linked indebted (and in some cases technically bankrupt) holding companies with profitable corporate satellites and which dissolved the characteristics of private and state-owned property to form what have recently been termed networks of 'recombinant property' or 'recombinets' (Stark 1996).
As in China the de-centralised and network type of organisation form facilitated foreign involvement. 'Ring fencing' allowed relatively risk-free entry by foreign investors but many international links fell short of legal joint ventures and simply amounted to sub-contracting elements of production processes to Hungarian enterprises which then established profit centres distinct from the core company as a way of evading the burden of excessive overhead costs. In this way fragmentation occurred not only between corporate satellites but also within them. In contrast to China where the majority of investment was in the form of horizontal modes of entry (such as joint ventures) direct foreign investment in Hungary involved hierarchical forms such as acquisition and greenfield projects. Thus the majority of direct foreign investment involved the formation of majority-owned subsidiaries of multinational companies and the construction of production facilities which formed nodes in international production networks (Swain 1996). Correspondingly such facilities were relatively isolated from the rest of the local productive economy.
A feature of the Hungarian economy and the emergence of dominant organisational forms was the significant continuing role of the state. The slow pace of privatisation (in part due to foreign investors preferring greenfield ventures to joint ventures) meant the state remained a significant asset owner. Moreover the relationship between the state and state enterprises remained similar to that which existed before the change of the political regime in the late 1980s, namely the state continued to lack the legitimacy and governance capacities needed to reorganise industry, which consequently remained subject to more or less soft budget constraints (Hendersen et al. 1995). The result was the emergence of a rump of producers which remained state-owned, either for strategic reasons or because of the inability to secure cash sales, and which had yet to embark on fundamental 'deep' restructuring (Whitley et al 1996).
Together these developments resulted in the emergence of a 'segmented economy' comprising three dominant types of organisational forms which were largely isolated from one another: decentralised 'recombinets', foreign-owned subsidiaries and state-owned enterprises. Notwithstanding the dispersed ownership pattern of the 'recombinets' (which were often ultimately state-owned) ownership was relatively concentrated and hierarchical in contrast to the pattern that existed toward the end of the central planning era. Whilst external control of managers by owners was significantly greater than was the case in Russia, monitoring was informal and depended on personal networks and administrative bargaining (Whitley et al 1996).
Although Grabher (1995) has argued that Hungary's dominant organisational forms are more interwoven than is the case in eastern Germany, it can be argued that the relative lack of interaction between the forms is a barrier to the emergence of new stable forms of corporate governance. This can be illustrated with reference to Magyar Suzuki Rt., the largest Hungarian car maker.
Case Example: Magyar Suzuki Rt. In 1990 the Suzuki Motor Corporation of Japan signed an agreement with the Hungarian government to construct a factory to assemble up to 60,000 'Suzuki Swifts' per annum in the northern town of Esztergom. The project was conceived in the late 1970s as a state-directed plan designed to enhance Hungary's increasingly weak position within the COMECON trading system. In return for providing car assembly capacity, Suzuki was to gain a monopoly position in the closed domestic market. Following five years of tortuous negotiations during which the political regime changed an agreement was signed and a new company was established in which Suzuki and a holding company comprising 62 state-owned engineering enterprises (Autokonzern) each had a 40pc share. Production at the plant commenced in October 1992. With the political changes Magyar Suzuki became an economically, politically and symbolically important joint venture as a state-directed national project designed to modernise the Hungarian engineering industry. Despite being a highly visible foreign investment the project was intimately connected to the state and state-owned enterprises. In addition to the involvement of Autokonzern, the project envisaged a local content of 30pc and was thus to involve contracting local state-owned suppliers. Moreover the Hungarian management comprised key individuals from state-owned auto enterprises and government ministries. As a result the project replicated the organisational behaviour that existed in the unreformed state-owned sector. The political and economic reforms forced a dramatic change in the rationale for the project from that of state-led industrial modernisation to the formation of a majority-owned European subsidiary of the Suzuki Corporation (Suzuki's share of the company had increased to 77.7pc by May 1996) managed by Japanese managers and designed to give Suzuki access to the increasingly protected (west) European car market. In order to secure preferential access to the Single European Market, Suzuki had to increase 'local content' to 60pc of the value of the car. Consequently it was forced to source more parts from Hungarian suppliers and/or encourage its suppliers back home to invest in the country. However, the perilous financial situation of local state-owned engineering enterprises and their inefficiency hindered contracting local suppliers. Additionally, the low volume of production and the risk of the venture dissuaded investments by Japanese suppliers. As Magyar Suzuki became increasingly desperate for local sources it fell back on the local sub-assembly of parts imported from Japan. In this way Suzuki found a way of evading the spirit if not the letter of the EU's rules on 'local content'. In another ominous sign for local manufactures Suzuki increasingly adopted a European sourcing policy. Thus Magyar Suzuki had been transformed into a 'transplant' with relative few local linkages.
In contrast to China, attempts to harness direct foreign investment as a tool for industrial modernisation and organisational change by encouraging interaction between different organisational forms seemed beyond the capacities of the Hungarian state. As a result it seemed likely that the segmentation of the economy would continue in which a cohort of modern foreign-owned subsidiaries linked into pan-European business systems co-existed largely separate from a pool of stagnant state-owned (and increasingly state-managed) loss-making enterprises lacking the financial and behavioural resources necessary to interact with and learn from the former group (cf. Ellingstad 1997). The prospects for the 'recombinets' appeared harder to predict although it seemed likely that as in China, agency problems might develop. Overall the labour market institutions and emerging capital markets in combination with the relative dominance of owners (the state and foreign companies) over managers seemed to suggest that Anglo-American forms of organisational governance were most likely to take hold (Whitley et al 1996). Thus in contrast to Russia and China, organisations in Hungary tended towards the hierarchy end of the 'hierarchies-market' continuum.
6. Conclusions
With the advanced state of economic reform programmes in Central and Eastern Europe (CEE) and increasingly so in the case of Russia and China, greater attention is being devoted to the problem of restructuring former state-owned enterprises. This paper has examined the nature of changes at the company level in Russia, China and Hungary, both from the point of view of problems of corporate governance and organisational restructuring. The use of detailed case studies has enabled insights to be gained into these issues which would most likely be difficult to capture in large-scale questionnaire surveys.
Despite certain similarities in the general direction of microeconomic reforms enterprise restructuring in these three countries is evolving along quite different routes.
In Russia, the reforming government has chosen large-scale 'voucher' privatisation as the main means to revitalise crumbling companies from the public sector. However, there is a growing recognition that whilst private ownership per se may address political issues, failure to deal with governance and finance problems means that in many cases the appropriate mechanisms within enterprises for stimulating efficiency are absent. New shareholders may replace the state but may contribute little in terms of either new capital for investment or effective shareholder voice in relation to enterprise strategy or operating efficiency. Given the widespread resistance to outsiders, foreign firms and investors need to develop a longer term strategy of establishing trust relationships with firms, perhaps through the pursuit of various forms of co-operative approaches such as strategic alliances. Resistance to outsiders suggests strongly that whole-firm acquisitions may be difficult to complete and also difficult to manage subsequently, although large-scale privatisation placed Russian companies closer to the market end of the 'market-hierarchy' continuum.
In China and Hungary, the process of economic liberalisation and strong government willingness to promote direct foreign investment has been followed by the development of hybrid bureaucratic-market organisational forms - networks of state and privately (mostly foreign) owned assets. While in Hungary ownership rights and residual claims are more or less clearly defined, in China this process of 'boundary-blurring' has resulted in the development of inter-organisational networks trying to internalise various transactions. As a result, these newly created networks in Hungary are based on vertical hierarchies of corporate governance, whereas in China large companies are making extensive use of various forms of horizontal integration.
Both in China and in Hungary these hybrid organisations have serious shortcomings in the long term from a corporate governance perspective. They are susceptible to two particularly important potential weaknesses: the multi-layer agency problem and the vulnerability of trust to free-riding. It seems that in the long term Russian privatised companies may have superior governance properties to the vaguely defined networks in China and Hungary, provided that a reliable legal infrastructure is put in place and enforced, and outside investors play a more active role in corporate governance mechanisms.
Igor Filatotchev and Adam Swain
School of Management and Finance
University of Nottingham
Tel: +44 (0) 115 951 5265
Fax: +44 (0) 115 951 5265
e-mail: Igor.Filatotchev@Nottingham.ac.uk
Acknowledgement.
Financial support for this research from Nuffield Foundation, the Economic and Social Research Council, and the European Union ACE-Tacis Programme is gratefully acknowledged.
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